QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 000-52045

Volcano Corporation

(Exact Name of Registrant as Specified in its Charter)

Delaware

33-0928885

(State or Other Jurisdiction of
Incorporation or Organization)

(I.R.S. Employer
Identification Number)

2870 Kilgore Road

Rancho Cordova, California

95670

(Address of Principal Executive Offices)

(Zip Code)

(800) 228-4728(Registrants telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer o Accelerated Filer o Non-accelerated Filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ

Indicate the number of shares of each of the issuers classes of common stock, as of the
latest practicable date:

Volcano Corporation (we, us, our or the company) designs, develops, manufactures and
commercializes a broad suite of intravascular ultrasound, or IVUS, and functional measurement, or
FM, products that we believe enhance the diagnosis and treatment of vascular and structural heart
disease. Vascular disease, or atherosclerosis, is caused by the accumulation of fat-laden cells in
the inner lining of the artery, leading to the formation of plaque or lesions. Accumulation of
plaque in the arteries narrows the diameter of the inner channel of the artery, or the lumen, which
reduces blood flow. During an IVUS procedure, an imaging catheter is placed inside an artery to
produce a cross-sectional image of the size and shape of the arterys lumen and provides
information concerning the composition and density of plaque or lesions and the condition of the
layers of the surrounding arterial walls. Our IVUS products consist of consoles, single-procedure
disposable catheters and advanced functionality options. FM devices measure the pressure and flow
characteristics of blood around plaque thereby allowing physicians to gauge the plaques impact on
blood flow and pressure. Our FM products consist of pressure and flow consoles and single-procedure
disposable pressure and flow guide wires.

We have prepared the accompanying financial information as of June 30, 2007 and for the three and
six months ended June 30, 2007 and 2006, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission, or SEC. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with U.S. generally accepted
accounting principles have been condensed or omitted pursuant to such rules and regulations. These
unaudited consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and the notes thereto included in our annual report on Form 10-K
for the year ended December 31, 2006.

In the opinion of management, the unaudited financial information as of June 30, 2007 and for the
three and six months ended June 30, 2007 and 2006 reflects all adjustments, which are normal
recurring adjustments, necessary to present a fair statement of financial position, results of
operations and cash flows. The results of operations for the three and six months ended June 30,
2007 are not necessarily indicative of the operating results for the full fiscal year or any future
periods.

Reverse Stock Split

On May 22, 2006, our Board of Directors and stockholders approved a 1-for-1.1 reverse split of our
common stock and, on May 24, 2006, we filed a Certificate of Amendment to our Restated Certificate
of Incorporation effecting the reverse split. All common share and per share amounts retroactively
reflect the reverse stock split. Except as otherwise noted, references to preferred stock do not
reflect the reverse stock split, as the conversion price for each series of preferred stock and the
number of shares of common stock into which each share of preferred stock is convertible were
adjusted, in accordance with the terms and conditions of such series of preferred stock, upon the
filing of the Certificate of Amendment to reflect the reverse stock split.

Concentrations of Credit Risk

Fukuda Denshi Co., Ltd., a distributor in Japan, accounted for 7.5% and 6.7% of our revenues in the
three and six months ended June 30, 2007, respectively, 12.1% and 17.2% for the three and six
months ended June 30, 2006, respectively, and 7.6% and 14.4% of our accounts receivable as of June
30, 2007 and December 31, 2006, respectively. Goodman Company, Ltd., a distributor in Japan,
accounted for 16.2% and 16.8% of our revenues in the three and six months ended June 30, 2007,
respectively, 10.1% and 7.0% for the three and six months ended June 30, 2006, respectively, and
17.6% and 14.7% of our accounts receivable as of June 30, 2007 and December 31, 2006, respectively.
No other single customer accounted for more than 10% of our revenues for any period presented and,
as of June 30, 2007 and December 31, 2006, no other single customer accounted for more than 10% of
our accounts receivable.

Stock-Based Compensation

On January 1, 2006, we adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised
2004), Share-Based Payment, (SFAS No. 123(R)) which requires the measurement and recognition of
compensation expense for all share-based payment awards made to employees and directors based on
estimated fair values. In March 2005, the Securities and Exchange Commission issued Staff

Accounting Bulletin No. 107 (SAB No. 107) relating to SFAS No. 123(R) and we have applied the
provisions of SAB No. 107 in our adoption of SFAS No. 123(R). Prior to January 1, 2006, we
accounted for share-based payments using the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), and related
Interpretations, as permitted by SFAS No. 123, Accounting for Stock-Based Compensation (SFAS No.
123). In accordance with APB No. 25, stock-based compensation expense had been recognized only when
the fair market value of our stock options granted to employees and directors was greater than the
exercise price of the underlying stock at the date of grant.

We adopted SFAS No. 123(R) using the modified-prospective-transition method. Under that transition
method, stock-based compensation cost recognized in the three and six months ended June 30, 2007
and 2006, includes stock-based compensation cost for all share-based payments granted prior to, but
not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance
with the original provisions of SFAS No. 123, and stock-based compensation cost for all share-based
payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in
accordance with the provisions of SFAS No. 123(R). SFAS No. 123(R) requires companies to estimate
the fair value of share-based payment awards on the date of grant using an option-pricing model.
The value of the portion of the award that is ultimately expected to vest is recognized as expense
over the requisite service periods. SFAS No. 123(R) requires forfeitures to be estimated at the
time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates. See Note 6. Stockholders Equity for additional information.

Product Warranty Costs

We offer a one-year warranty for parts and labor on our products commencing upon the transfer of
title and risk of loss to the customer. We accrue the estimated cost of product warranties at the
time revenue is recognized based on historical results. The warranty obligation is affected by
product failure rates, material usage and service delivery costs incurred in correcting a product
failure. Should actual product failure rates, material usage or service delivery costs differ from
these estimates, revisions to the estimated warranty liability would be required. We periodically
assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary.

Accrued warranty liability is included in accrued expenses and other current liabilities in the
consolidated balance sheets. The change in the accrued warranty liability for the six months ended
June 30, 2007 and 2006 is summarized in the following table (in thousands):

Six Months Ended

June 30,

2007

2006

Balance at beginning of period

$

706

$

359

Warranties issued

1,547

358

Settlements

(971

)

(296

)

Balance at end of period

$

1,282

$

421

Net Loss Per Share

Basic and diluted net loss per share is presented in accordance with SFAS No. 128, Earnings per
Share. Basic net loss per share is computed by dividing consolidated net loss by the
weighted-average number of common shares outstanding during the period. For the three and six
months ended June 30, 2007 and 2006, our potential dilutive shares, which include outstanding
common stock options and warrants have not been included in the computation of diluted net loss per
share, as the result would be anti-dilutive. Such potentially dilutive shares are excluded when the
effect would be to reduce a net loss per share. Shares issuable upon exercise of warrants to
purchase common stock, which require little or no cash consideration from the holder are included
in basic net loss per share using the treasury stock method. Warrants to purchase an aggregate of
up to 3,091,216 shares of our common stock at an exercise price of $0.011 per share have been
reflected in the calculation of basic and diluted net loss per share using the treasury stock
method until their date of exercise in June 2006, at which time, these warrants were automatically
exercised in connection with our June 2006 initial public offering of common stock per the original
terms of the warrants.

The basic and diluted net loss per share calculations for the three and six months ended June 30,
2007 and 2006 are as follows (in thousands, except per share data):

Three Months Ended

Six Months Ended

June 30,

June 30,

2007

2006

2007

2006

Net loss

$

(3,855

)

$

(4,163

)

$

(2,181

)

$

(10,537

)

Weighted-average common shares outstanding

38,438

7,362

38,202

5,593

Shares issuable upon exercise of certain warrants



2,715



2,900

Shares used for basic and diluted net loss per share

38,438

10,077

38,202

8,493

Basic and diluted net loss per share

$

(0.10

)

$

(0.41

)

$

(0.06

)

$

(1.24

)

Potential common shares that would have the effect of decreasing basic net loss per share are
considered to be antidilutive. In accordance with SFAS No. 128, these shares were not included in
calculating diluted earnings per share. The following table sets forth potential shares of common
stock, as of June 30, 2007 and 2006, that are not included in the diluted net loss per share
calculation because their effect would be anti-dilutive (in thousands):

2007

2006

Stock options outstanding

4,978

5,011

Warrants to purchase convertible preferred stock



170

Warrants to purchase common stock

127

43

Unvested common stock subject to repurchase

12

58

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No.157, Fair Value Measurements (SFAS 157), which defines
fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair
value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates
inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 will be
effective for fiscal years beginning after November 15, 2007 and we will adopt SFAS 157 for our
fiscal year beginning January 1, 2008. We are currently assessing the potential impact the adoption
of SFAS 157 will have on our consolidated results of operations and financial position.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities  Including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159
expands the use of fair value accounting but does not affect existing standards which require
assets or liabilities to be carried at fair value. Under SFAS 159, a company may elect to use fair
value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities,
equity method investments, accounts payable, guarantees and issued debt. Other eligible items
include firm commitments for financial instruments that otherwise would not be recognized at
inception and non-cash warranty obligations where a warrantor is permitted to pay a third party to
provide the warranty goods or services. If the use of fair value is elected, any upfront costs and
fees related to the item must be recognized in earnings and cannot be deferred, e.g., debt issue
costs. The fair value election is irrevocable and generally made on an instrument-by-instrument
basis, even if a company has similar instruments that it elects not to measure based on fair value.
At the adoption date, unrealized gains and losses on existing items for which fair value has been
elected are reported as a cumulative adjustment to beginning retained earnings. Subsequent to the
adoption of SFAS 159, changes in fair value are recognized in earnings. SFAS 159 is effective for
fiscal years beginning after November 15, 2007 and we will adopt SFAS 159 for our fiscal year
beginning January 1, 2008. We are currently determining whether fair value accounting is
appropriate for any of the eligible items and we cannot estimate the impact, if any, the adoption
of SFAS 159 will have on our consolidated results of operations and financial position.

Short-term investments have been classified as available-for-sale securities. At June 30, 2007,
cash, cash equivalents and investments are detailed as follows (in thousands):

Gross

Gross

Unrealized

Unrealized

Gross

Losses

Losses

Unrealized

Less Than

12 Months or

Estimated Fair

Cost

Gains

12 Months

Longer

Value

Non interest bearing cash

$

2,709

$



$



$



$

2,709

Money market funds

22,793







22,793

Certificates of Deposit

2,500







2,500

Corporate bonds

22,881

1

(6

)



22,876

Asset backed obligations

6,255



(1

)



6,254

Commercial paper

39,736

3

(1

)



39,738

Total

$

96,874

$

4

$

(8

)

$



$

96,870

As of June 30, 2007, all of our investments mature within one year. These investments are recorded
at their estimated fair value with unrealized gains or losses reported as a separate component of
accumulated other comprehensive loss.

Inventories

Inventories consist of the following (in thousands):

June 30,

December 31,

2007

2006

Finished goods

$

5,185

$

5,302

Work-in-process

4,958

2,529

Raw materials

7,861

5,592

Total

$

18,004

$

13,423

3. Debt and Credit Facilities and Warrants

Our outstanding debt, including current maturities, was $1.6 million and $1.7 million at June 30,
2007 and December 31, 2006, respectively.

Revolving Credit Facility

In July 2003, to provide working capital and for general corporate purposes, we entered into a
revolving credit facility agreement with a bank. Effective July 2004 and 2005, we amended this
revolving credit facility and in conjunction with these amendments, the credit facility was
increased from $6.0 million to $8.0 million and from $8.0 million to $10.0 million, respectively.
In April 2006, the revolving credit facility was amended and renewed and in July 2006, the
revolving credit facility agreement was further amended. In May 2007, the credit facility expired
as scheduled.

Senior Subordinated Debt

Pursuant to a subordinated debt agreement entered into in December 2003, we repaid the outstanding
balance of $29.2 million on our senior subordinated notes, as required by their terms, with the
proceeds from our June 2006 initial public offering.

Intangible assets consist of developed technology, customer relationships, licenses, and patents
and trademarks, which are amortized using the straight-line method over periods ranging from three
to ten years, representing the estimated useful lives of the assets. During the six months ended
June 30, 2007, we recorded intangible asset additions of $138,000 related to internally developed
patents and trademarks.

Intangible assets subject to amortization, by major class, consist of the following (in thousands):

June 30, 2007

Weighted-

Accumulated

Average Life

Cost

Amortization

Net

(in years)

Developed technology

$

12,469

$

7,673

$

4,796

6.5

Licenses

7,034

3,114

3,920

9.8

Customer relationships

1,674

1,030

644

6.5

Patents and trademarks

1,507

345

1,162

9.6

$

22,684

$

12,162

$

10,522

7.4

At June 30, 2007, future amortization expense associated with our intangible assets is expected to
be as follows (in thousands):

2007 (six months)

$

1,499

2008

2,998

2009

2,998

2010

822

2011

822

Thereafter

1,383

Total

$

10,522

5. Commitments and Contingencies

Litigation

From time to time we become subject to legal proceedings in the ordinary course of our
business. We are not currently involved in any legal proceedings that we believe will, either
individually or in the aggregate, materially and adversely affect our business. Legal fees and
other costs associated with such actions are expensed as incurred and were not material in any
period reported. Additionally, we assess, based in part on information received from our legal
counsel, the need to record a liability for litigation and contingencies. Reserve estimates are
recorded when and if it is determined that a loss related matter is both probable and reasonably
estimable. We believe that the ultimate disposition of these matters will not have a material
impact on our results of operations, financial position or cash flows.

Purchase Commitments

We have obligations under non-cancelable purchase commitments, primarily for production materials.
As of June 30, 2007, the future minimum payments under these non-cancelable purchase commitments,
all requiring payment in 2007, totaled $10.6 million.

Indemnification

Our supplier, distributor and collaboration agreements generally include certain provisions for
indemnification against liabilities if our products are recalled, infringe a third-partys
intellectual property rights or cause bodily injury due to alleged defects in our products. In
addition, we have agreements with our Board of Directors, our President and Chief Executive Officer
and our Chief Financial Officer indemnifying them against liabilities arising from such actions. To
date, we have not incurred any material costs as a result of such indemnifications and have not
accrued any liabilities related to such obligations in the accompanying consolidated financial
statements.

In May 2006, our stockholders approved a resolution to increase the number of authorized shares of
our common stock to 250,000,000, which became effective upon the completion of our initial public
offering. In May 2006 and June 2007, our stockholders approved increases in the number of shares
subject to our 2005 equity compensation plan by 2,272,727 shares and 3,500,000 shares,
respectively, to a total of 11,662,558. As of June 30, 2007, we have reserved 9,595,000 shares and
127,400 shares of our common stock for the issuance of options under our stock option plans and the
exercise of common stock warrants, respectively.

Stockholders Rights Plan

In May 2006, our stockholders approved a stockholders rights plan and a classified board of
directors with staggered terms of election. Pursuant to the stockholder rights plan, we declared
and paid a dividend of one right for each share of common stock. Unless redeemed prior to the time
the rights are exercised, upon the occurrence of certain events, the rights will entitle the
holders to receive shares of our preferred stock, or shares of an acquiring entity. The
stockholders rights plan and the classified board of directors became effective upon the completion
of our initial public offering in June 2006.

Public Offerings of our Common Stock

On June 15, 2006, we completed an initial public offering in which 7,820,000 shares of our common
stock were sold to the public at an offering price of $8.00 per share. The initial public offering
resulted in net proceeds of $54.5 million, after deducting offering expenses and underwriting
discounts and commissions. Of the net proceeds, $29.2 million was used to repay our senior
subordinated debt, as required by its terms and $750,000 was used to pay the outstanding balance of
our short-term debt. In conjunction with the offering, all of our outstanding shares of preferred
stock were converted into 18,123,040 shares of our common stock immediately prior to the closing of
the offering and certain warrants to purchase 3,103,943 shares of our common stock were by their
terms, automatically exercised on a cash-less basis upon the closing of the offering, resulting in
the net issuance of 3,097,943 shares of our common stock.

On December 12, 2006, we completed a follow-on offering in which 3,500,000 shares of our common
stock were sold by the company and 4,000,000 shares were sold by certain selling stockholders,
including officers of the company. In addition, we sold 795,000 shares under an over-allotment
option exercised by the underwriters. The follow-on offering, including the exercise of the
over-allotment option, resulted in net proceeds to the company of $66.8 million, after deducting
offering expenses and underwriting discounts and commissions.

Warrants

As of June 30, 2007, there is a warrant outstanding to purchase 127,400 shares of our common stock
at a price of $3.30 per share. The warrant is immediately exercisable by the holder and expires on
June 30, 2011.

Employee Stock Purchase Plan

On June 7, 2007, our stockholders approved the adoption of our 2007 Employee Stock Purchase Plan
(the Purchase Plan). The Purchase Plan provides for the purchase of up to an aggregate of 500,000
shares of common stock of the company, subject to annual increases approved by the Board of
Directors. The Purchase Plan provides eligible employees the opportunity to purchase shares of
Volcano Corporation common stock at the lower of up to a 15%
discount from the fair market value on the first or
last day of the applicable offering period, by having withheld from their salary an amount up to
15% of their compensation. No employee may purchase more than $25,000 worth of common stock
(calculated at the time the purchase right is granted) in any calendar year, nor may purchase more
than 750 shares in any six-month purchase period. The Purchase Plan is administered by the
Compensation Committee of the Board of Directors and it is anticipated that the first offering
period will begin on September 1, 2007. At the beginning of each
offering period, the Compensation Committee approves the discount
from the fair market value and the employee withholding percentage. As of June 30, 2007, there were a total of 500,000 shares
of common stock reserved for issuance under the Purchase Plan.

Stock-Based Compensation

As of June 30, 2007, we have granted options under the 2005 Equity Compensation Plan (the 2005
Plan) and the 2000 Long Term Incentive Plan (the 2000 Plan) under which a maximum aggregate number
of 11,662,558 shares of our common stock may be issued or transferred to our employees,
non-employee directors and consultants. Effective October 2005, all options will be granted under
the

2005 Plan. Options previously granted under the 2000 Plan that are cancelled or expire will
increase the shares available for grant under the 2005 Plan. The terms of grant vary by plan and as
of June 30, 2007, 4,616,983 shares remained available to grant.

The following table sets forth stock-based compensation expense included in the Companys
consolidated statements of operations (in thousands):

Three Months Ended

Six Months Ended

June 30,

June 30,

2007

2006

2007

2006

Cost of revenues

$

140

$

68

$

253

$

136

Selling, general and administrative

1,126

601

2,049

1,107

Research and development

217

127

424

242

Included in the table above is $112,000 and $207,000 of stock-based compensation expense related to
non-employees in the three months and six months ended June 30, 2007, respectively, and $135,000
and $271,000 in the three months and six months ended June 30, 2006, respectively. Additionally,
there was $242,000 and $152,000 of total stock-based compensation cost capitalized in inventory as
of June 30, 2007 and December 31, 2006, respectively.

We have not recognized, and we do not expect to recognize in the near future, any tax benefit
related to employee stock-based compensation cost as a result of the full valuation allowance on
our net deferred tax assets and our net operating loss carryforwards.

We use the Black-Scholes-Merton option-pricing model (Black-Scholes model). Option valuation
models require the input of highly subjective assumptions including the expected life of the
stock-based award and the expected stock price volatility. The assumptions discussed here represent
managements best estimates, but these estimates involve inherent uncertainties and the application
of management judgment. As a result, if other assumptions had been used, the recorded and pro forma
stock-based compensation expense could have been materially different. In addition, we are required
to estimate the expected forfeiture rate and only recognize expense for those shares expected to
vest. If the actual forfeiture rate is materially different from the estimate, the stock-based
compensation expense could be materially different.

The fair value of each option is estimated on the date of grant using the Black-Scholes
option-pricing model utilizing the following assumptions:

Three Months Ended

Six Months Ended

June 30,

June 30,

2007

2006

2007

2006

Risk-free interest rate

4.5%  5.0%

5.0

%

4.5%  5.0%

4.6%  5.0%

Expected life (years)

4.75

4.75

4.75

4.75

Estimated volatility

50%  52%

55

%

50%  54%

55%  61%

Expected dividends

None

None

None

None

Risk-Free Interest RateWe base the risk-free interest rate used in the Black-Scholes valuation
method on the implied yield currently available on U.S. Treasury constant maturity securities with
the same or substantially equivalent remaining term.

Expected LifeOur expected life represents the period that the stock-based awards are expected to
be outstanding. With the adoption of SFAS No. 123(R) on January 1, 2006, as permitted by SAB No.
107, we adopted a temporary shortcut approach to developing the estimate of the expected term of
an employee stock option. Under this approach, the expected life is presumed to be the mid-point
between the vesting date and the contractual end of the option grant. The short-cut approach is
not permitted for options granted, modified or settled after December 31, 2007. Prior to the
adoption of SFAS No. 123(R), the expected life of our stock options was determined based on
historical experience of similar awards, giving consideration to the contractual terms of the
share-based awards, vesting schedules and expectations of future employee behavior as influenced by
changes to the terms of our share-based awards.

Estimated VolatilityWe calculate volatility based upon the trading history and implied volatility
of the common stock of comparable medical device companies in determining an estimated volatility
when using the Black-Scholes option-pricing formula to determine the fair value of options granted.

Expected DividendsSince we have not declared any dividends in the past, we use a zero value for
the expected dividend value factor when using the Black-Scholes option-pricing formula to determine
the fair value of options granted.

Estimated ForfeituresWhen estimating forfeitures, we considered voluntary and involuntary
termination behavior as well as analysis of actual option forfeitures.

A summary of the status of our non-vested shares as of June 30, 2007 and changes during the six
months ended June 30, 2007 is as follows:

Weighted-Average

Grant Date Fair

Shares

Value

Non-vested shares at December 31, 2006

1,891,033

$

3.94

Grants of options

1,230,456

9.49

Vesting of options

(623,272

)

4.14

Forfeitures or expirations of options

(48,847

)

5.72

Non-vested shares at June 30, 2007

2,449,370

6.64

Option activity for the six months ended June 30, 2007 is as follows:

Weighted-

Weighted-

Average

Average

Remaining

Aggregate

Exercise

Contractual Life

intrinsic value

Shares

Price

(in years)

(in thousands)

Outstanding at December 31, 2006

4,672,408

$

2.98

Grants of options

1,230,456

19.22

Exercises

(876,377

)

1.65

Forfeitures or expirations

(48,847

)

10.00

Outstanding and exercisable at June 30, 2007

4,977,640

7.16

6.6

$

65,042

Vested and expected to vest as of June 30, 2007

4,810,161

7.00

6.6

$

63,620

As required by SFAS No. 123(R), we made an estimate of expected forfeitures and we are recognizing
compensation cost only for those equity awards expected to vest.

The total intrinsic value of stock options exercised during the six months ended June 30, 2007 was
$15.4 million, which represents the difference between the exercise price of the option and the
estimated fair value of our common stock on the dates exercised. As of June 30, 2007, $13.5 million
of total unrecognized compensation cost related to stock options issued to employees is expected to
be recognized over a weighted average term of 3.1 years.

7. Segment and Geographic Information

Our chief operating decision-maker reviews financial information presented on a consolidated basis,
accompanied by disaggregated information about revenues by geographic region for purposes of making
operating decisions and assessing financial performance. Accordingly, we consider ourselves to be
in a single reporting segment, specifically the manufacture, sale, discovery, development and
commercialization of products for the diagnosis of atherosclerosis in the coronary arteries and
peripheral vascular system. We do not assess the performance of our geographic regions on other
measures of income or expense, such as depreciation and amortization, operating income or net
income. In addition, our assets are primarily located in the United States and are not allocated to
any specific region. We do not produce reports for, or measure the performance of, our geographic
regions on any asset-based metrics. Therefore, geographic information is presented only for
revenues.

Revenues for the three and six months ended June 30, 2007 and 2006 based on geographic location are
summarized in the following table (in thousands):

Three Months Ended

Six Months Ended

June 30,

June 30,

2007

2006

2007

2006

Revenues:

United States

$

15,189

$

13,969

$

30,416

$

23,885

Japan

7,473

5,751

15,124

11,059

Europe, the Middle East and Africa

5,622

5,233

10,931

8,917

Rest of world

1,268

910

2,660

1,874

$

29,552

$

25,863

$

59,131

$

45,735

8. Income Taxes

We accrue interest and penalties on underpayment of income taxes related to unrecognized tax
benefits as a component of income tax expense in our consolidated statements of operations. No
amounts were recognized for interest and penalties upon adoption of FIN 48 or during the three
months ended June 30, 2007.

The Company is subject to taxation in the U.S. and various state and foreign jurisdictions. We
record liabilities for income tax contingencies based on our best estimate of the underlying
exposures. We have not been audited by any jurisdiction since our inception in 2000. We are open
for audit by the U.S. Internal Revenue Service and state tax jurisdictions from our inception in
2000 to 2006. We are open for audit by Belgium and various European tax jurisdictions from the
inception of Volcano Europe S.A./N.V. in 2003 to 2006. We are open for audit by Japan tax
jurisdictions since the inception of Volcano Japan Co. Ltd. in 2006.

For the three and six month periods ended June 30, 2007, we recorded a provision for income taxes
of approximately $158,000 and $368,000, respectively. For the three and six month periods ended
June 30, 2006, we recorded a $14,000 benefit and a $19,000 provision, respectively. The provision
for income taxes consisting primarily of foreign income taxes and domestic state taxes.

9. Related Parties

Medtronic, Inc. and Its Affiliates

We have collaborations with Medtronic, Inc. and certain of its affiliates (collectively,
Medtronic). Medtronic was an investor in our Series B Preferred Stock. In connection with our
initial public offering in June 2006, their investment in our preferred stock automatically
converted into shares of our common stock. In December 2006, Medtronics ownership in our company
was reduced when they sold common stock as a selling stockholder in an underwritten public offering
of our common stock.

In July 2003, we were paid a $2.5 million license fee by Medtronic in exchange for the fully paid,
royalty-free, perpetual, irrevocable, worldwide license. The license fee has been deferred and is
being recognized as revenue over the estimated 10-year term of the agreement. The amount recorded
in revenues totaled $62,500 during each the three month periods ended June 30, 2007 and 2006 and
$125,000 during each of the six month periods ended June 30, 2007 and 2006. At June 30, 2007, the
amount deferred was $1.5 million, of which $250,000 was reflected in the current portion of
deferred revenues. In addition, we recorded revenues related to the sale of a component of our IVUS
catheter totaling $157,000 and $205,000 to Medtronic during the three and six months ended June 30,
2007, respectively, and $593,000 and $889,000 during the three and six month periods ended June 30,
2006. At June 30, 2007 and December 31, 2006, there was $38,000 and $5,000 due from Medtronic,
respectively.

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, particularly statements that may relate to, but
are not limited to, expectations of future operating results or financial performance, capital
expenditures, introduction of new products, regulatory compliance, plans for growth and future
operations, as well as assumptions relating to the foregoing. Forward-looking statements are
inherently subject to risks and uncertainties, some of which cannot be predicted or quantified.
These risks and other factors include, but are not limited to, those listed under Part II, Item 1A
 Risk Factors and elsewhere in this report. In some cases, you can identify forward-looking
statements by terminology such as may, will, should, could, expect, plan, anticipate,
believe, estimate, predict, intend, potential, continue or the negative of these terms
or other comparable terminology. These statements are only predictions. Actual events or results
may differ materially and adversely.

Overview

We design, manufacture and commercialize a broad suite of intravascular ultrasound, or IVUS, and
functional measurement, or FM, products that we believe enhance the diagnosis and treatment of
vascular and structural heart disease. Our products seek to deliver all of the benefits associated
with conventional IVUS and FM devices, while providing enhanced functionality and proprietary
features that address the limitations associated with conventional forms of these technologies. As
a result, we believe that our IVUS and FM products have the potential to become the standard of
care to address the needs of patients, hospitals, physicians and third-party payors on a
cost-effective basis.

We have corporate infrastructure in the United States, Europe and Japan, direct sales capabilities
in the United States and a combination of direct sales and distribution relationships in
international markets, including Japan, Europe, the Middle East, Africa, Canada, Asia Pacific and
Latin America. Our corporate headquarters, located in Rancho Cordova, California, contains our
worldwide manufacturing and research and development operations. We have sales offices in
Alpharetta, Georgia and Tokyo, Japan, sales and distribution offices in Zaventem, Belgium, a
third-party distribution facility in Chiba, Japan, a research and development facility in
Cleveland, Ohio and an administrative office in San Diego, California.

We have focused on building our U.S. and international sales and marketing infrastructure to market
our products to physicians and technicians who perform percutaneous interventional procedures in
hospitals and to other personnel who make purchasing decisions on behalf of hospitals. As of June
30, 2007, we had approximately 550 worldwide employees, including approximately 250 manufacturing
employees, 140 sales and marketing employees and approximately 70 research and development
employees. Included in the 140 sales and marketing employees are 19 marketing employees, 95 sales
and sales support employees in the United States, 12 sales and sales support employees in Europe, 8
sales and sales support employees in Japan and two direct sales representatives responsible for
Asia.

In the six months ended June 30, 2007 and 2006, 18.7% and 19.5%, respectively, of our revenues and
14.5% and 13.8%, respectively, of our operating expenses were denominated in foreign currencies,
primarily the Euro. As a result, we are subject to risks related to fluctuations in foreign
currency exchange rates, which could affect our operating results in the future.

Our IVUS products are comprised of consoles, single-procedure disposable catheters and advanced
functionality options. Our family of consoles includes the IVUS In-Vision Gold, or IVG, and the
PC-based s5. The s5 family of products was launched in 2006 and is our primary console offering. We
continue to develop advanced functionality options including real-time VH IVUS, IVUS, and phased
array and rotational catheter compatibility. Our single-procedure disposable IVUS catheters only
operate and interface with our family of IVUS consoles. We believe we are the only company
worldwide that offers both phased array and rotational catheters.

Our FM products consist of pressure and flow consoles and single-procedure disposable pressure and
flow guide wires. Our FM consoles are mobile, proprietary and high speed electronic systems with
different functionalities and sizes designed and manufactured to process and display the signals
received from our guide wires.

We have developed and are continuing to develop customized cath lab versions of our consoles and
advanced functionality options as part of our vfusion cath lab integration initiative. The
significantly expanded functionality of our vfusion offering allows for networking of patient
information, control of IVUS and FM information at both the operating table and in the cath lab
control room, as well as the capability for images to be displayed on standard cath lab monitors.
We expect to continue to develop new products and technologies to expand our vfusion offering.

As of June 30, 2007, we had a worldwide installed base of over 2,000 IVUS consoles and over 700 FM
consoles. We intend to grow and leverage this installed base to drive recurring sales of our
single-procedure disposable catheters and guide wires. In the six months ended June 30, 2007, the
sale of our single-procedure disposable catheters and guide wires accounted for $44.7 million, or
75.7% of our revenues, an $8.1 million, or 22.1%, increase from the same period in 2006, in which
the sale of our single-procedure disposable catheters and guide wires accounted for $36.6 million,
or 80.1% of our revenues.

We manufacture our IVUS and FM consoles, IVUS catheters and FM guide wires at our facility in
Rancho Cordova, California. We use third-party manufacturing partners to produce circuit boards and
mechanical sub-assemblies used in the manufacture of our consoles. We also use third-party
manufacturing partners for certain proprietary components used in the manufacture of our
single-procedure disposable products. We perform incoming inspection on these circuit boards,
mechanical sub-assemblies and components, assemble them into finished products, and test the final
product to assure quality control.

As a development stage company from our inception in January 2000 until July 2003, we were engaged
principally in the research and development of tools designed to diagnose vulnerable plaque. In
July 2003, we purchased substantially all of the assets and assumed certain liabilities associated
with the IVUS and FM product lines of Jomed, Inc., or the Jomed Acquisition. We also acquired
certain IVUS patents and technology from Koninklijke Philips Electronics, N.V. in July 2003. These
purchases were significant in executing our strategy to leverage our IVUS technology and build our
business.

In March 2006, we entered into a supply and distribution agreement with GE, pursuant to which we
collaborated on the development and distribution of our s5i GE Innova product, which is our IVUS
imaging system console that is installed directly into a cath lab on a permanent basis and is able
to be integrated with GEs Innova system. Under the terms of the agreement, GE has been granted
exclusive distribution rights worldwide, excluding Japan, for the s5i GE Innova product for a
period of 12 months, subject to minimum purchase forecasts, and non-exclusive distribution rights
thereafter. The 12-month exclusivity period expires on August 14, 2007. GE has also been granted
non-exclusive distribution rights worldwide, excluding Japan, for our s5i product. Unless extended,
or terminated earlier in accordance with its terms, the agreement will expire on December 31, 2009.
GEs obligation to purchase products from us under the agreement is limited to firm purchase orders
made by GE and accepted by us. No minimum purchase requirements are required and the forecasts to
be provided under the agreement will not be binding. While we have not previously entered into a
distribution arrangement that is similar to our agreement with GE, we believe our relationship with
GE will enable us to increase sales of our consoles worldwide, excluding Japan.

We completed our initial public offering on June 15, 2006 in which we sold 7,820,000 shares of our
common stock to the public at an offering price of $8.00 per share. The initial public offering
resulted in net proceeds of $54.5 million, after deducting offering expenses and underwriting
discounts and commissions. Of the net proceeds, $29.2 million was used to repay our senior
subordinated debt, as required by its terms. In addition, through
June 30, 2007, $3.1 million was
used for other debt repayment, $6.5 million was used for capital
expenditures and $422,000 was used
for the acquisition of intangibles. The remaining net proceeds have been invested in short-term
investments in accordance with our investment policy. In conjunction with our initial public
offering, all our outstanding shares of preferred stock were converted into 18,123,040 shares of
our common stock immediately prior to the closing of the offering and certain warrants to purchase
3,103,943 shares of our common stock were, by their terms, automatically exercised on a cash-less
basis upon the closing of the offering, resulting in the net issuance of 3,097,943 shares of our
common stock.

On December 12, 2006, we completed a follow-on public offering in which 3,500,000 shares of our
common stock were sold by the company and 4,000,000 shares were sold by certain selling
stockholders, including officers of the company. In addition, we sold 795,000 shares under an
over-allotment option exercised by the underwriters. The follow-on offering, including the exercise
of the over-allotment option, resulted in net proceeds to the Company of $66.8 million, after
deducting offering expenses and underwriting discounts and commissions.

The following is a description of the primary components of our revenue and expenses.

Revenues. We derive our revenues primarily from the sale of our IVUS and FM consoles and
single-procedure disposables. In the six months ended June 30, 2007, 85.7% of our revenues were
derived from the sale of our IVUS consoles and IVUS single-procedure disposables, as compared with
84.1% in the six months ended June 30, 2006. In the six months ended June 30, 2007, 11.8% of our
revenues were derived from the sale of our FM consoles and FM single-procedure disposables, as
compared with 13.2% in the six months ended June 30, 2006. Other revenues consist primarily of
spare parts sales, service and maintenance revenues, shipping and handling revenues and license
fees.

Our sales in the United States are generated by our direct sales representatives and our products
are shipped to hospitals throughout the United States from our facility in Rancho Cordova,
California. Our international sales are generated by our direct sales representatives or through
independent distributors and are shipped throughout the world from our facilities in Rancho
Cordova, California, Zaventem, Belgium and Chiba, Japan.

We expect to continue to experience variability in our quarterly revenues from IVUS and FM consoles
due in part to the timing of hospital capital equipment purchasing decisions. Further, we expect
variability of our revenues based on the timing of our new product introductions which may cause
our customers to delay their purchasing decisions until the new products are commercially
available. Alternatively, we may include in our arrangements with customers an obligation to
deliver new products which are not yet commercially available. In these cases, we would be required
to defer associated revenues from these customers until we have met our delivery obligations.

Cost of Revenues. Cost of revenues consists primarily of material costs for the products that we
sell and other costs associated with our manufacturing process such as personnel costs, rent and
depreciation. In addition, cost of revenues includes royalty expenses for licensed technologies
included in our products, service costs, provisions for warranty, distribution, freight and
packaging costs and stock-based compensation expense. We expect our gross margin to remain flat to
slightly down over the next few quarters as we prepare the Japanese market for the release of our
rotational product. Thereafter, we expect our gross margin to improve if we are able to complete
our ongoing efforts to streamline and improve our manufacturing processes and increase production
volumes.

Selling, General and Administrative. Selling, general and administrative expenses consist
primarily of salaries and other related costs for personnel serving the sales, marketing,
executive, finance, information technology and human resource functions. Other costs include travel
and entertainment expenses, facility costs, trade show, training and other promotional expenses,
professional fees for legal and accounting services and stock-based compensation expense. We expect
that our selling, general and administrative expenses will increase as we add sales personnel and
as we continue to be subject to the reporting obligations applicable to public companies, including
compliance with the requirements under the Sarbanes-Oxley Act of 2002.

Research and Development. Research and development expenses consist primarily of salaries and
related expenses for personnel, consultants, prototype materials, clinical studies, depreciation,
regulatory filing fees, certain legal costs related to our intellectual property and stock-based
compensation expense. We expense research and development costs as incurred. We expect our research
and development expenses to increase as we continue to develop our products and technologies.

Amortization of Intangibles. Intangible assets, which consist of our developed technology,
licenses, customer relationships, patents and trademarks, are amortized using the straight-line
method over their estimated useful lives ranging from three to ten years.

Interest Expense. Interest expense is comprised primarily of interest expense on our notes
payable, short-term debt and term loans and the amortization of debt discount and deferred
financing fees. We expect interest expense in 2007 to decrease as a result of the June 2006
repayment of the outstanding balance of $29.2 million on our senior subordinated notes and as we
continue to pay down our remaining debt balances in 2007 and 2008.

Interest and Other Income (Expense), Net. Interest and other income (expense), net is comprised of
interest income from our cash and cash equivalents, interest income from our short-term
available-for-sale investments and gains and losses on foreign currency transactions.

Provision (Benefit) for Income Taxes. Provision (benefit) for income taxes is comprised of
Federal, state, local and foreign income taxes. Due to uncertainty surrounding the realization of
deferred tax assets through future taxable income, we have provided a full

valuation allowance against these assets in the United States and Europe. Federal and state income
tax expense reflects current taxes expected to be paid. Foreign tax expense includes current taxes
expected to be paid in Europe and current and deferred tax expense on income reported in Japan.

Results of Operations

The following table sets forth items derived from our consolidated statements of operations for the
three and six months ended June 30, 2007 and 2006, presented in both absolute dollars (in
thousands) and as a percentage of revenues:

Three Months Ended June 30,

Six Months Ended June 30,

Percent

Percent

Percent

Percent

of

of

of

of

2007

Revenues

2006

Revenues

2007

Revenues

2006

Revenues

Revenues :

$

29,552

100.0

$

25,863

100.0

$

59,131

100.0

$

45,735

100.0

Cost of revenues

12,316

41.7

11,468

44.3

23,181

39.2

19,688

43.0

Gross profit

17,236

58.3

14,395

55.7

35,950

60.8

26,047

57.0

Operating expenses:

Selling, general and administrative

15,682

53.1

11,613

44.9

28,266

47.8

23,258

50.8

Research and development

5,716

19.3

4,317

16.7

10,404

17.6

8,870

19.4

Amortization of intangibles

776

2.6

777

3.0

1,562

2.6

1,551

3.4

Total operating expenses

22,174

75.0

16,707

64.6

40,232

68.0

33,679

73.6

Operating loss

(4,938

)

(16.7

)

(2,312

)

(8.9

)

(4,282

)

(7.2

)

(7,632

)

(16.7

)

Interest expense

(72

)

(0.2

)

(2,454

)

(9.5

)

(161

)

(0.3

)

(3,766

)

(8.2

)

Interest and other income
(expense), net

1,313

4.4

589

2.3

2,630

4.4

880

1.9

Loss before provision (benefit) for
income taxes

(3,697

)

(12.5

)

(4,177

)

(16.1

)

(1,813

)

(3.1

)

(10,518

)

(23.0

)

Provision (benefit) for income
taxes

158

0.5

(14

)



368

0.6

19



Net loss

$

(3,855

)

(13.0

)

$

(4,163

)

(16.1

)

$

(2,181

)

(3.7

)

$

(10,537

)

(23.0

)

The following table sets forth our revenues by geography expressed as dollar amounts (in
thousands) and the changes in revenues between the specified periods expressed as percentages:

Three Months Ended June 30,

Six Months Ended June 30,

Percentage

Percentage

2007

2006

Change

2007

2006

Change

Revenues(1):

United States

$

15,189

$

13,969

8.7

$

30,416

$

23,885

27.3

Japan

7,473

5,751

29.9

15,124

11,059

36.8

Europe, the Middle East and Africa

5,622

5,233

7.4

10,931

8,917

22.6

Rest of world

1,268

910

39.3

2,660

1,874

41.9

$

29,552

$

25,863

14.3

$

59,131

$

45,735

29.3

(1)

Revenues are attributed to countries based on location of the customer, except for original
equipment manufacturer revenues which are attributed to the geography of the legal entity
invoicing.

The following table sets forth our revenues by product expressed as dollar amounts (in
thousands) and the changes in revenues between the specified periods expressed as percentages:

Three Months Ended June 30,

Six Months Ended June 30,

Percentage

Percentage

2007

2006

Change

2007

2006

Change

IVUS:

Consoles

$

6,272

$

4,902

27.9

$

12,095

$

6,914

74.9

Single-procedure disposables

19,271

17,036

13.1

38,585

31,537

22.3

FM:

Consoles

390

565

(31.0

)

798

945

(15.6

)

Single-procedure disposables

2,881

2,653

8.6

6,158

5,110

20.5

Other

738

707

4.4

1,495

1,229

21.6

$

29,552

$

25,863

14.3

$

59,131

$

45,735

29.3

Comparison of Three Months Ended June 30, 2007 and 2006

Revenues. Revenues increased $3.7 million, or 14.3%, to $29.6 million in the three months ended
June 30, 2007, as compared to revenues of $25.9 million in the three months ended June 30, 2006. In
the three months ended June 30, 2007, IVUS revenue increased $3.6 million, or 16.4%, as compared to
the three months ended June 30, 2006. The $3.6 million increase in IVUS revenue is comprised of
$2.2 million from higher sales volume of our single-procedure disposable IVUS products
and $1.4 million from an increase in sales of our IVUS consoles, as compared to the
three months ended June 30, 2006. The increase in IVUS console revenue in the three months ended
June 30, 2007, resulted from higher sales volume of our newer s5 family of consoles compared to
sales of our previous generation IVG consoles during the three months ended June 30, 2006. Our FM
revenues increased $53,000, or 1.6%, for the three months ended
June 30, 2007, as compared to June 30, 2006. Increases in
revenues were realized across all our key markets.

Cost of Revenues. Cost of revenues increased $849,000, or 7.4%, to $12.3 million, or 41.7% of
revenues in the three months ended June 30, 2007, from $11.5 million, or 44.3% of revenues in the
three months ended June 30, 2006. The decrease in cost of revenues as a percent of revenues in the
three months ended June 30, 2007 is primarily due to an increase in the average selling price and a
decrease in production cost of certain IVUS catheters, as well as increased average selling prices
for certain FM disposables.

Gross margin was 58.3% of revenues in the three months ended June 30, 2007 as compared to 55.7% of
revenues in the three months ended June 30, 2006. The improvement in gross margin in the three
months ended June 30, 2007 as compared with the three months ended June 30, 2006 was primarily a
result of an increase in the average selling price and a decrease in production cost of certain
IVUS catheters, as well as increased average selling prices for certain FM disposables. This gross
margin favorability was partially offset by higher warranty and freight expenses.

Selling, General and Administrative. Selling, general and administrative expenses increased $4.1
million, or 35.0%, to $15.7 million, or 53.1% of revenues in the three months ended June 30, 2007,
as compared to $11.6 million, or 44.9% of revenues in the three months ended June 30, 2006. The
increase in the three months ended June 30, 2007 as compared with the three months ended June 30,
2006 was primarily due to increased sales headcount, higher professional fees to comply with the
requirements of the Sarbanes-Oxley Act, higher stock-based compensation expense and higher
marketing expenses for increased headcount and promotional activities.

Research and Development. Research and development expenses increased $1.4 million, or 32.4%, to
$5.7 million, or 19.3% of revenues in the three months ended June 30, 2007, as compared to $4.3
million, or 16.7% of revenues in the three months ended June 30, 2006. The increase in research and
development expenses in the three months ended June 30, 2007, was primarily due to higher product
development project costs and payroll-related costs associated with increased headcount.

Amortization of Intangibles. Amortization expense was relatively constant at $776,000, or 2.6% of
revenues in the three months ended June 30, 2007, as compared to $777,000, or 3.0% of revenues in
the three months ended June 30, 2006.

Interest Expense. Interest expense decreased $2.4 million, or 97.1% to $72,000, or 0.2% of
revenues in the three months ended June 30, 2007, as compared to $2.5 million, or 9.5% of revenues
in the three months ended June 30, 2006. The decrease was entirely due to a reduction in debt
primarily from the pay off of $29.2 million of our senior subordinated notes in June 2006.

Interest and Other Income (Expense), Net. Interest and other income (expense), net was $1.3
million in the three months ended June 30, 2007, as compared to $589,000 in the three months ended
June 30, 2006. The change in the three months ended June 30, 2007 as compared to the three months
ended June 30, 2006 was primarily attributable to a $1.2 million increase in interest income due to
higher cash and cash equivalents and short-term available-for-sale investment balances following
our June 2006 initial public offering and our December 2006 secondary offering.

Provision
(Benefit) for Income Taxes. Provision for income taxes for the three months ended June
30, 2007 was $158,000 compared to a benefit of $14,000 for the three months ended June 30, 2006.
The increase is principally attributable to higher foreign income taxes in 2007.

Comparison of Six Months Ended June 30, 2007 and 2006

Revenues. Revenues increased $13.4 million, or 29.3%, to $59.1 million in the six months ended
June 30, 2007, as compared to revenues of $45.7 million in the six months ended June 30, 2006. In
the six months ended June 30, 2007, IVUS revenue increased $12.2 million, or 31.8%, as compared to
the six months ended June 30, 2006. The $12.2 million increase in IVUS revenue is comprised of $7.0
million from higher sales volume of our single-procedure disposable IVUS products and
$5.2 million from an increase in sales of our IVUS consoles, as compared to the six
months ended June 30, 2006. The increase in IVUS console revenue in the six months ended June 30,
2007, resulted from higher sales volume of our newer s5 family of consoles compared with sales of
our previous generation IVG consoles during the six months ended June 30, 2006. Our FM revenues
increased $901,000, or 14.9%, for the six months ended June 30,
2007 as compared to June 30, 2006. Increases in revenues were
realized across all our key markets.

Cost of Revenues. Cost of revenues increased $3.5 million, or 17.7%, to $23.2 million, or 39.2% of
revenues in the six months ended June 30, 2007, from $19.7 million, or 43.0% of revenues in the six
months ended June 30, 2006. The decrease in cost of revenues as a percent of revenues in the six
months ended June 30, 2007 is primarily due to an increase in the average selling price and a
decrease in production cost of certain IVUS catheters, as well as increased average selling prices
for certain FM disposables.

Gross margin was 60.8% of revenues in the six months ended June 30, 2007 as compared to 57.0% of
revenues in the six months ended June 30, 2006. The improvement in gross margin in the six months
ended June 30, 2007 as compared with the six months ended June 30, 2006 was primarily a result of
an increase in the average selling price and a decrease in production cost of certain IVUS
catheters, as well as increased average selling prices for certain FM disposables. This gross
margin favorability was partially offset by higher warranty and freight expenses.

Selling, General and Administrative. Selling, general and administrative expenses increased $5.0
million, or 21.5%, to $28.3 million, or 47.8% of revenues in the six months ended June 30, 2007, as
compared to $23.3 million, or 50.9% of revenues in the six months ended June 30, 2006. The increase
in the six months ended June 30, 2007 as compared with the six months ended June 30, 2006 was
primarily due to increased sales headcount, higher professional fees to comply with the
requirements of the Sarbanes-Oxley Act, higher stock-based compensation expense, and increased
marketing expenses for increased headcount and promotional activities.

Research and Development. Research and development expenses increased $1.5 million, or 17.3%, to
$10.4 million, or 17.6% of revenues in the six months ended June 30, 2007, as compared to $8.9
million, or 19.4% of revenues in the six months ended June 30, 2006. The increase in research and
development expenses in the six months ended June 30, 2007, was primarily due to higher product
development project costs, payroll-related costs associated with increased headcount and increased
clinical and regulatory costs.

Amortization of Intangibles. Amortization expense was relatively constant at $1.6 million, or 2.6%
of revenues in the six months ended June 30, 2007, compared to $1.6 million, or 3.4% of revenues in
the six months ended June 30, 2006. The increase in amortization expense was related to internally
developed patent and trademark costs incurred and capitalized in 2006.

Interest Expense. Interest expense decreased $3.6 million, or 95.7% to $161,000, or 0.3% of
revenues in the six months ended June 30, 2007, as compared to $3.8 million, or 8.2% of revenues in
the six months ended June 30, 2006. The decrease was entirely due to a reduction in debt primarily
from the pay off of $29.2 million of our senior subordinated notes in June 2006.

Interest and Other Income (Expense), Net. Interest and other income (expense), net was $2.6
million in the six months ended June 30, 2007, as compared to $880,000 in the six months ended June
30, 2006. The change in the six months ended June 30, 2007 as compared to the six months ended June
30, 2006 was primarily attributable to a $2.2 million increase in interest income due to higher
cash and cash equivalents and short-term available-for-sale investment balances following our June
2006 initial public offering and our December 2006 secondary offering, partially offset by a
$493,000 decrease in foreign exchange rate gains.

Provision for income taxes. Provision for income taxes for the six months ended June 30, 2007 and
June 30, 2006 was $368,000 and $19,000, respectively. The increase is principally attributable to
higher foreign income taxes in 2007.

Liquidity and Capital Resources

Sources of Liquidity

At June 30, 2007, our cash and cash equivalents and short-term available-for-sale investments
totaled $96.9 million. We invest our excess funds in short-term securities issued by corporations,
banks, municipalities and financial holding companies and in money market funds comprised of these
same types of securities.

On June 15, 2006, we completed an initial public offering of 7,820,000 shares of our common stock,
which included 1,020,000 shares sold pursuant to the exercise of the underwriters over-allotment
option. Proceeds of the offering, after deducting offering expenses and underwriting discounts and
commissions were $54.5 million. Pursuant to a subordinated debt agreement entered into in December
2003, we repaid the outstanding balance of $29.2 million on our senior subordinated notes, as
required by their terms, with a portion of the proceeds from our initial public offering.

On December 12, 2006, we completed a follow-on public offering in which 3,500,000 shares of our
common stock were sold by the company and 4,000,000 shares were sold by certain selling
stockholders, including officers of the company. In addition, we sold 795,000 shares under an
over-allotment option exercised by the underwriters. The follow-on offering, including the exercise
of the over-allotment option, resulted in net proceeds to the Company of $66.8 million, after
deducting offering expenses and underwriting discounts and commissions.

At June 30, 2007, our accumulated deficit was $66.2 million. Since inception, we have generated
significant operating losses and as a result we did not generate sufficient cash flow to fund our
operations and the growth in our business. Accordingly, we had financed our operations and
acquisitions primarily through the issuances of $62.5 million of preferred stock, $20.0 million of
senior subordinated notes and $7.0 million of term loans. These issuances of equity and debt were
supplemented with borrowings from our revolving credit facility and equipment financing
arrangements. In addition, in July 2003, we financed a portion of our acquisition of certain IVUS
patents and technology by entering into a non-interest bearing note with Philips in the amount of
$3.3 million. The issuances of our senior subordinated notes, term loans and our revolving credit
facility included warrants to purchase our Series B preferred stock, which automatically converted
into warrants to purchase common stock upon the completion of our initial public offering, or our
common stock.

Cash Flows

Cash Flows from Operating Activities. Cash provided by operating activities of $4.1 million for
the six months ended June 30, 2007 reflected our net loss of $2.2 million, offset by adjustments
for non-cash expenses consisting primarily of depreciation and amortization of $3.7 million and
stock-based compensation expense of $2.7 million. In addition, accounts receivable decreased $1.1
million and accounts payable increased $3.0 million. The decrease in accounts receivable and
increase in accounts payable was primarily due to the timing of
receipts and payments. These amounts
were partially offset by a $4.5 million increase in inventories, primarily due to increased
manufacturing activity.

Cash used in operating activities of $6.2 million for the six months ended June 30, 2006 reflected
our net loss of $10.5 million, offset by adjustments for non-cash expenses consisting primarily of
depreciation and amortization of $4.8 million, interest capitalized as debt principal of $2.0
million, stock-based compensation expense of $1.5 million and the amortization of debt discount and
deferred financing fees of $1.6 million. In addition, accounts payable and accrued liabilities
decreased $5.2 million, which resulted primarily from the timing of payments.

Cash Flows from Investing Activities. Cash used in investing activities was $29.9 million in the
six months ended June 30, 2007 and $2.6 million in the six months ended June 30, 2006. During the
six months ended June 30, 2007, $51.9 million was used to purchase short-term available-for-sale
securities and $3.9 million was used for capital expenditures, primarily for medical diagnostic
equipment. This was partially offset by $25.9 million from the maturity of short-term
available-for-sale securities. Cash used in investing activities during the three months ended June
30, 2006 was primarily from capital expenditures for medical diagnostic equipment and manufacturing
equipment.

Capital expenditures were $3.9 million in the six months ended June 30, 2007. We expect that our
capital expenditures in 2007 will be approximately $10.0 million to $11.0 million, primarily for
the purchase of medical diagnostic equipment, manufacturing equipment and equipment to support our
research and development activities.

Cash Flows from Financing Activities. Cash provided by financing activities was $1.1 million in
the six months ended June 30, 2007, due to $1.4 million in proceeds from the exercise of employee
stock options, partially offset by the repayment of $363,000 of long-term debt. Cash provided by
financing activities was $24.2 million in the six months ended June 30, 2006, primarily due to the
net proceeds of $54.5 million from our initial public offering, partially offset by the repayment
of debt of $31.1 million.

Future Liquidity Needs

Our future liquidity and capital requirements will be influenced by numerous factors, including the
extent and duration of future operating losses, the level and timing of future sales and
expenditures, the results and scope of ongoing research and product development programs, working
capital required to support our sales growth, the receipt of and time required to obtain regulatory
clearances and approvals, our sales and marketing programs, the continuing acceptance of our
products in the marketplace, competing technologies and market and regulatory developments. As of
June 30, 2007, we believe our current cash and cash equivalents and our short-term
available-for-sale investments will be sufficient to fund working capital requirements, capital
expenditures, debt service and operations for at least the next 12 months. We intend to retain any
future earnings to support operations and to finance the growth and development of our business,
and we do not anticipate paying any dividends in the foreseeable future.

Our ability to fund our longer-term cash needs is subject to various risks, many of which are
beyond our control  See Part II, Item 1A  Risk Factors. Should we require additional funding,
such as to satisfy our short-term and long-term debt obligations when due, or to make additional
capital investments, we may need to raise the required additional funds through bank borrowings or
public or private sales of debt or equity securities. We cannot assure that such funding will be
available in needed quantities or on terms favorable to us.

The discussion and analysis of our financial condition and results of operations are based upon our
unaudited condensed consolidated financial statements, which have been prepared in accordance with
U.S. generally accepted accounting principles. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses. On an on-going basis, we evaluate our critical accounting
policies and estimates. We base our estimates on historical experience and on various other
assumptions that we believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates under different
assumptions or conditions. Our critical accounting policies and estimates are discussed in our
Annual Report on Form 10-K for the fiscal year ended December 31, 2006 and there have been no
material changes other than to the income taxes policy discussed below .

Our accounting policy for income taxes was recently modified due to the adoption of Interpretation
No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) and is described below.

In June 2006, the Financial Accounting Standards Board (FASB) issued FIN 48. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprises financial statements in
accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes
(FAS 109). This interpretation prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or expected to be taken in
a tax return. FIN 48 also provides guidance on derecognition of tax benefits, classification on the
balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition.
FIN 48 requires significant judgment in determining what constitutes an individual tax position as
well as assessing the outcome of each tax position. Changes in judgment as to recognition or
measurement of tax positions can materially affect the estimate of the effective tax rate and
consequently, affect our operating results. We adopted FIN 48 effective January 1, 2007, and the
adoption did not have a material impact on our consolidated financial position or results of
operations.

Off-Balance Sheet Arrangements

As of June 30, 2007, we did not have any off-balance sheet arrangements that have or are reasonably
likely to have current or future material effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital
resources.

Contractual Obligations

There have been no material changes to the contractual obligations during the period covered by
this report, outside of the ordinary course of business, from those disclosed in our annual report
on Form 10-K for the year ended December 31, 2006.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of changes in the value of market risk sensitive instruments caused
by fluctuations in interest rates, foreign exchange rates and commodity prices. Changes in these
factors could cause fluctuations in our results of operations and cash flows. In the ordinary
course of business, we are exposed to interest rate and foreign exchange risk. Fluctuations in
interest rates and the rate of exchange between the U.S. dollar and foreign currencies, primarily
the Euro, could adversely affect our financial results.

Our exposure to interest rate risk at June 30, 2007, is related to the investment of our excess
cash into highly liquid, short-term financial investments. We invest in money market funds in
accordance with our investment policy. The primary objectives of our investment policy are to
preserve principal, maintain proper liquidity to meet operating needs and maximize yields. Our
investment policy specifies credit quality standards for our investments. Due to the short-term
nature of our investments, we have assessed that there is no material exposure to interest rate
risk arising from them.

We are exposed to foreign currency risk related to our European operations, including Euro
denominated intercompany receivables. We also have a note payable denominated in Euros with a third
party. Because our intercompany receivables and our note payable are accounted for in Euros, any
appreciation or devaluation of the Euro will result in a gain or loss to the consolidated
statements of operations.

Under the supervision and with the participation of our management, including our chief executive
officer and our chief financial officer, we carried out an evaluation of the effectiveness of the
design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934. Based on that evaluation, these officers have
concluded that, as of June 30, 2007, our disclosure controls and procedures were effective.

Disclosure controls and procedures are controls and other procedures that are designed to ensure
that information required to be disclosed in our reports filed under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported within the time periods specified in the SECs
rules and forms. Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed in our reports filed under
the Securities Exchange Act of 1934 is accumulated and communicated to management, including our
chief executive officer and chief financial officer as appropriate, to allow timely decisions
regarding required disclosure.

Changes in internal control over financial reporting

Under the supervision and with the participation of our management, including our chief executive
officer and our chief financial officer, we carried out an evaluation of any potential changes in
our internal control over financial reporting during the fiscal quarter covered by this quarterly
report on Form 10-Q. There were no changes in our internal control over financial reporting during
such period that have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.

Limitations on the effectiveness of controls

Our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance
that the objectives of our disclosure control system are met. Because of inherent limitations in
all control systems, no evaluation of controls can provide absolute assurance that all control
issues, if any, within a company have been detected.

From time to time we become subject to legal proceedings in the ordinary course of our
business. We are not currently involved in any legal proceedings that we believe will, either
individually or in the aggregate, materially and adversely affect our business.

Item 1A. Risk Factors

This Risk Factors section provides updated information in certain areas from the Risk Factors
set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 (the
Annual Report). Set forth below are certain risk factors that have been expanded or updated from
the Annual Report. The risks and uncertainties described in the Annual Report, as expanded or
updated below do not constitute all the risk factors that pertain to our business but we do believe
that they reflect the more important ones. Please review the Annual Report for a complete listing
of Risk Factors that pertain to our business.

We have a limited operating history, have incurred significant operating losses since inception and
cannot assure you that we will achieve profitability.

We were formed in January 2000 and until 2003 were a development stage company substantially
devoted to the research and development of tools designed to diagnose vulnerable plaque. In July
2003, we acquired substantially all of the assets related to the IVUS and functional measurement,
or FM, product lines from Jomed, Inc., or the Jomed Acquisition, and commenced the manufacturing,
sale and distribution of IVUS and FM products. We have yet to demonstrate that we have sufficient
revenues to become a sustainable, profitable business. Even if we do achieve significant revenues,
we expect our operating expenses will increase as we expand our business to meet anticipated
growing demand for our products and as we devote resources to our sales, marketing and research and
development activities. If we are unable to reduce our cost of revenues and our operating expenses,
we may not achieve profitability. As of June 30, 2007, we had an accumulated deficit of $66.2
million. Although we have reported net income after taxes in the three month periods ended
September 30, 2006, December 31, 2006 and March 31, 2007, we expect to experience quarterly
fluctuations in our revenues due to the timing of capital purchases by our customers and to a
lesser degree the seasonality of disposable consumption by our customers and our expenses as we
make future investments in research and development, selling and marketing and general and
administrative activities that will cause us to experience variability in our reported earnings and
losses in future periods. Failure to achieve and sustain profitability would negatively impact the
market price of our common stock.

Competition from companies that have longer operating histories and greater resources than us may
harm our IVUS business.

The medical device industry, including the market for IVUS products, is highly competitive, subject
to rapid technological change and significantly affected by new product introductions and market
activities of other participants. As a result, even if the size of the IVUS market increases, we
can make no assurance that our revenues will increase. In addition, as the markets for medical
devices, including IVUS products, develop, additional competitors could enter the market. To
compete effectively, we will need to continue to demonstrate that our products are attractive
alternatives to other devices and treatments. We believe that our continued success depends on our
ability to:

With respect to our IVUS products, our biggest competitor is Boston Scientific. We also compete in
Japan with Terumo Corporation. Boston Scientific, Terumo and other potential competitors are
substantially larger than us and may enjoy competitive advantages, including:



more established distribution networks;



entrenched relationships with physicians;



products and procedures that are less expensive;



broader range of products and services that may be sold in bundled arrangements;

greater experience in obtaining and maintaining the FDA and other regulatory clearances and approvals;



established relationships with healthcare providers and payors; and



greater financial and other resources for product development, sales and marketing, acquisitions of
products and companies, and intellectual property protection.

For these reasons, we may not be able to compete successfully against our current or potential
future competitors, and sales of our IVUS products may decline.

We are dependent on our collaborations, and events involving these collaborations or any future
collaborations could delay or prevent us from developing or commercializing products.

The success of our current business strategy and our near- and long-term viability will depend on
our ability to execute successfully on existing strategic collaborations and to establish new
strategic collaborations. Collaborations allow us to leverage our resources and technologies and to
access markets that are compatible with our own core areas of expertise. To penetrate our target
markets, we may need to enter into additional collaborative agreements to assist in the development
and commercialization of future products. Establishing strategic collaborations is difficult and
time-consuming. Potential collaborators may reject collaborations based upon their assessment of
our financial, regulatory or intellectual property position and our internal capabilities. Our
discussions with potential collaborators may not lead to the establishment of new collaborations on
favorable terms.

We have collaborations with Medtronic, Inc. and certain of its affiliates, or Medtronic, The
Cleveland Clinic Foundation, GE and Philips. In each collaboration, we combine our technology or
core capabilities with that of the third party to either permit greater penetration into markets,
as in the case of Medtronic, GE and Philips, or enhance the functionality of our current and
planned products, as in the case of The Cleveland Clinic Foundation.

We have limited control over the amount and timing of resources that our current collaborators or
any future collaborators devote to our collaborations or potential products. These collaborators
may breach or terminate their agreements with us or otherwise fail to conduct their collaborative
activities successfully and in a timely manner. Further, our collaborators may not develop or
commercialize products that arise out of our collaborative arrangements or devote sufficient
resources to the development, manufacture, marketing or sale of these products. Moreover, in the
event of termination of a collaboration agreement, termination negotiations may result in less
favorable terms.

To market and sell our products, we depend on third-party distributors, and they may not be
successful.

We currently depend on third-party distributors to sell our products. If these distributors are not
successful in selling our products, we may be unable to increase or maintain our level of revenue.
Over the long term, we intend to grow our business internationally, and to do so we will need to
attract additional distributors to expand the territories in which we do not directly sell our
products. Our distributors may not commit the necessary resources to market and sell our products.
If current or future distributors do not perform adequately or if we are unable to locate
distributors in particular geographic areas, we may not realize revenue growth internationally.

A significant portion of our annual revenue is derived from sales to our Japanese distributors,
primarily Fukuda Denshi, Goodman and Johnson & Johnson K.K., Medical Company (Johnson & Johnson).
In the six months ended June 30, 2007, we generated revenues of $15.1 million from sales to our
Japanese distributors. Additionally, Fukuda Denshi has sub-distribution agreements with other
parties who act as sub-distributors of our products. While these multi-level agreements allow us to
access specific customers and markets, they create complex distribution arrangements and increase
our reliance on our Japanese distributors. We entered into an agreement with Fukuda Denshi in March
2006 that extended our commercial relationship though June 2012. This agreement became effective
upon the transfer of the related regulatory approvals held by Fukuda Denshi, which took place on
June 1, 2006. We entered into a distribution agreement with Johnson & Johnson in December 2006. A
significant change in our relationship with our distributors or in the relationships between our
distributors may have a negative impact on our ability to sustain and grow our business in Japan.

In certain other international markets, we also use distributors. Other than Japan, no one market
in which we use distributors represents a significant portion of our revenues but, in the
aggregate, problems with these distribution arrangements could negatively affect our international
sales strategy, negatively impact our revenues and the market price of our stock. In addition, in
the event that we experience any difficulties under our March 2006 agreement with GE for our s5i
and s5i GE Innova IVUS, or in coordinating our efforts with GE, our revenue from the sale of our
s5i and s5i GE Innova IVUS products will be adversely affected.

The risks inherent in our international operations may adversely impact our revenues, results of
operations and financial condition.

We derive, and anticipate we will continue to derive, a significant portion of our revenues from
operations in Japan and Europe. In the six months ended June 30, 2007, revenues to customers
located in Japan and Europe were $15.1 million and $10.9 million, representing 25.6% and 18.5%,
respectively, of our total revenue. As we expand internationally, we will need to hire, train and
retain qualified personnel for our direct sales efforts and retain distributors and train their
personnel in countries where language, cultural or regulatory impediments may exist. We cannot
ensure that distributors, physicians, regulators or other government agencies will accept our
products, services and business practices. In addition, we purchase some components on the
international market. The sale and shipment of our products and services across international
borders, as well as the purchase of components from international sources, subject us to extensive
U.S. and foreign governmental trade regulations. Compliance with such regulations is costly. Any
failure to comply with applicable legal and regulatory obligations could impact us in a variety of
ways that include, but are not limited to, significant criminal, civil and administrative
penalties, including imprisonment of individuals, fines and penalties, denial of export privileges,
seizure of shipments and restrictions on certain business activities. Failure to comply with
applicable legal and regulatory obligations could result in the disruption of our shipping and
sales activities. Our international sales operations expose us and our representatives, agents and
distributors to risks inherent in operating in foreign jurisdictions, including:



our ability to obtain, and the costs associated with obtaining, U.S. export licenses and other required
export or import licenses or approvals;

difficulties in enforcing or defending agreements and intellectual property rights; and



changes in foreign political or economic conditions.

We cannot ensure that one or more of these factors will not harm our business. Any material
decrease in our international revenues or inability to expand our international operations would
adversely impact our revenues, results of operations and financial condition.

Our products may in the future be subject to product recalls or voluntary market withdrawals that
could harm our reputation, business and financial results.

The FDA and similar foreign governmental authorities have the authority to require the recall of
commercialized products in the event of material deficiencies or defects in design or manufacture
that could affect patient safety. In the case of the FDA, the authority to require a recall must be
based on an FDA finding that there is a reasonable probability that the device would cause serious
adverse health consequences or death. In addition, foreign governmental bodies have the authority
to require the recall of our products in the event of material deficiencies or defects in design or
manufacture. Manufacturers may, under their own initiative, recall a product if any material
deficiency in a device is found. A government-mandated recall or voluntary recall or market
withdrawal by us or one of our distributors could occur as a result of component failures,
manufacturing errors, design or labeling defects or other deficiencies and issues. Recalls or
voluntary withdrawals of any of our products would divert managerial and financial resources, and
have an adverse effect on our financial condition and results of operations. A recall or voluntary
withdrawal could harm our reputation with customers, affect revenues and negatively affect our
stock price.

We
depend on one distributor to hold the regulatory approvals related to certain of our products
imported into Japan and for ongoing regulatory compliance, and difficulties involving this
relationship will impair our ability to sell these products in Japan.

Goodman currently distributes our FM products in Japan and is responsible for Japanese regulatory
compliance in relation to these products, including obtaining and maintaining the applicable
regulatory approvals and ensuring ongoing compliance with Japanese laws and regulations relating to
importation and sale. We have neither the capability nor the authority to import or sell our FM
products in Japan and are dependent on Goodman to do so. In the six months ended June 30, 2007 and
2006, sales of our FM products in Japan accounted for 13.0% and 13.3%, respectively, of our FM
product revenues and 1.5% and 1.8%, respectively, of our total revenues. Our distribution
relationship with Goodman is based on an agreement executed in 1994. By its terms, this agreement
expired in 1999 unless extended by mutual written agreement. No formal amendment to the agreement
has extended its terms. However, Goodman and we have continued to operate in accordance with its
terms, including the adoption of new pricing exhibits, placement and fulfillment of orders, and
payment of invoices, since we acquired certain FM assets in 2003. In July 2007, Goodman obtained
regulatory approval relating to the importation and sale of our rotational catheter and certain
related hardware in Japan. If Goodman fails to maintain regulatory compliance related to our FM and
rotational products, we will be unable to sell these products in Japan. Furthermore, if Goodman
successfully argues that it is under no obligation to distribute our products and ceases to
distribute our products, we will no longer be able to sell these products in Japan.

Our
manufacturing operations are dependent upon third party source suppliers, which makes us vulnerable to
supply problems, price fluctuations and manufacturing delays.

We rely on AMI Semiconductors, Inc., or AMIS, for the supply of application specific integrated
circuits, or ASICs, and for the supply of wafers used in the manufacture of our IVUS IVG consoles
and our catheters. These ASICs and wafers are critical to these products, and there are relatively
few alternative sources of supply. We do not carry a significant inventory of either component. If
we had to change suppliers, we expect that it would take at least a year, and possibly 18 months or
longer, to identify an appropriate replacement supplier, complete design work and undertake the
necessary inspections before the ASICs or wafers would be available. We rely on International Micro
Industries, Inc., or IMI, to undertake additional processing of certain of the ASICs that are
produced by AMIS for use in the manufacture of our catheters. We do not carry a significant
inventory of the circuits that are finished by IMI. We expect that in the event it is necessary to
replace IMI, it would take at least three months, and possibly six months or longer, to identify an
appropriate replacement supplier that is able to undertake the additional processing on the ASICs.
We are not parties to supply agreements with either AMIS or IMI but instead use purchase orders as
needed.

We also rely on Silicon Microstructures, Inc., or SMI, for the supply of pressure sensors used in
the manufacture of our FM wires. SMI has notified us that they will stop producing our product on
4 wafers and that we will need to make an end-of-life purchase of product in order to secure any
remaining inventory from them. An estimated four-year supply is being procured from SMI to provide
adequate time for us to initiate and qualify a replacement supplier or new design to replace the
product that SMI has stopped manufacturing. We expect that it will take 18 to 24 months to identify
an appropriate replacement supplier, complete design work and undertake the necessary inspections
before the new pressure sensors will be available.

We also rely upon Endicott Interconnect Technologies (EIT) for the assembly operation of the
scanner used on the IVUS catheters. We do not carry a significant inventory of the scanner
assemblies that are finished by EIT. We expect that in the event it is necessary to replace EIT for
the assembly operation, it would take at least six months, and possibly a year, to identify and
qualify an appropriate replacement supplier that is able to undertake the additional assembly
operation. A Materials Supply Agreement is in place with EIT for the assembly of the scanner
devices.

In addition, we implemented a new automated system to replace certain customized equipment which is no longer produced
or supported by a third party for the manufacture of the scanners located on our phased array catheters. The new automated
system is located at EITs facility and we are dependent on EIT
for the day-to-day control and protection of the system. If the new
automated system does not perform as expected, or if we are not
provided with product as requested, or if we are not provided
access to the system, we may encounter delays in the manufacture of
our catheters and may not have sufficient inventory to
meet our customers demands, which could negatively impact our revenues.

Our reliance on these sole source suppliers subjects us to a number of risks that could impact our
ability to manufacture our products and harm our business, including:



inability to obtain adequate supply in a timely manner or on commercially reasonable terms;



interruption of supply resulting from modifications to, or discontinuation of, a suppliers operations;



delays in product shipments resulting from uncorrected defects, reliability issues or a suppliers
variation in a component;



uncorrected quality and reliability defects that impact performance, efficacy and safety of products
from replacement suppliers;



price fluctuations due to a lack of long-term supply arrangements for key components with our suppliers;



difficulty identifying and qualifying alternative suppliers for components in a timely manner;



production delays related to the evaluation and testing of products from alternative suppliers and
corresponding regulatory qualifications; and



delays in delivery by our suppliers due to changes in demand from us or their other customers.

Any significant delay or interruption in the supply of components or materials, or our inability to
obtain substitute components or materials from alternate sources at acceptable prices and in a
timely manner, could impair our ability to meet the demand of our customers and harm our business.
Identifying and qualifying additional or replacement suppliers for any of the components or
materials used in our products may not be accomplished quickly or at all and could involve
significant additional costs. Any supply interruption from our suppliers or failure to obtain
additional suppliers for any of the components or materials used to manufacture our products would
limit our ability to manufacture our products and could therefore have a material adverse effect on
our business, financial condition and results of operations.

In addition, it is likely that we will need to expand our manufacturing capacity within the next two years. We expect
that any expansion would be achieved through modified space utilization in our current leased facilities, improved
efficiencies, automation and acquisition of additional tooling and equipment. We may not have, or be able to obtain, the
required funds to expand our manufacturing capacity if necessary.

We may require significant additional capital to pursue our growth strategy, and our failure to
raise capital when needed could prevent us from executing our growth strategy.

We believe that our existing cash and cash equivalents and short-term available-for-sale
investments will be sufficient to meet our anticipated cash needs for at least the next 12 months.
However, we may need to obtain additional financing to pursue our business strategy, to respond to
new competitive pressures or to act on opportunities to acquire or invest in complementary
businesses, products or technologies. The timing and amount of our working capital and capital
expenditure requirements may vary significantly depending on numerous factors, including:



market acceptance of our products;



the revenues generated by our products



the need to adapt to changing technologies and technical requirements, and the costs related thereto;



the costs associated with expanding our manufacturing, marketing, sales and distribution efforts; and



the existence and timing of opportunities for expansion, including acquisitions and strategic transactions.

If our capital resources are insufficient to satisfy our liquidity requirements, we may seek to
sell additional equity or debt securities or to obtain debt financing. The sale of additional
equity or debt securities, or the use of our stock in an acquisition or strategic transaction,
would result in additional dilution to our stockholders. Additional debt would result in increased
expenses and could result in covenants that would restrict our operations. Our significant losses
to date may prevent us from obtaining additional funds on favorable terms, if at all. We have not
made arrangements to obtain additional financing, and there is no assurance that financing, if
required, will be available in amounts or on terms acceptable to us, if at all.

Our debt agreements contain terms that place restrictions on the operation of our business, and our
failure to comply with these terms could put us in default, which would harm our business and
operations.

Our revolving credit facility expired in May 2007 according to the terms of the credit facility.
Our remaining debt agreements contain a number of covenants. These covenants limit our ability to,
among other things:



incur additional debt and liens;



pay dividends; and



sell or dispose of any of our assets outside the normal course of business.

We are also subject to additional covenants, which require us to notify the lender upon the
occurrence of certain events. Failure to meet any of these covenants could result in an event of
default under our outstanding debt agreements. In the event of a default, our lenders may take one
or more of the following actions:



increase our borrowing costs;



further restrict our ability to obtain additional borrowings;



accelerate payment on all amounts outstanding; and



enforce their interests against collateral pledged.

If any lender accelerates our debt payments, our assets may not be sufficient to fully pay down our
debt.

In addition, as we cannot declare dividends or incur additional debt without the written approval
from our lenders, our ability to raise additional capital could be severely restricted. Our ability
to receive the necessary approvals is largely dependent upon our relationship with our lenders and
our performance, and no assurances can be given that we will be able to obtain the necessary
approvals in the future. Our inability to raise additional capital could lead to working capital
deficits that could have a material adverse effect on our operations.

If our products, or malfunction of our products, cause or contribute to death or serious injury, we
will be subject to medical device reporting regulations, which can result in voluntary corrective
actions or agency enforcement actions.

Under the FDA medical device reporting regulations, medical device manufacturers are required to
report to the FDA information that a device has or may have caused or contributed to a death or
serious injury or has or may have a malfunction that would likely cause or contribute to death or
serious injury if the malfunction were to recur. All manufacturers placing medical devices on the
market in the European Union are legally bound to report any serious or potentially serious
incidents involving devices they produce or sell to the Competent Authority in whose jurisdiction
the incident occurred. Were this to happen to us, the relevant Competent Authority would file an
initial report, and there would then be a further inspection or assessment if there are particular
issues. This would be carried out either by the Competent Authority or it could require that the
BSI, as the Notified Body, carry out the inspection or assessment.

Malfunction of our products could result in future voluntary corrective actions, such as recalls or
customer notifications, or agency action, such as inspection or enforcement action. Such
malfunctions have been reported to us in the past. No injury to patients resulted from any of these
incidents, but we can make no assurance that any future incident would not result in harm to
patients. Upon learning of the malfunctions, we have taken all actions required by law and notified
the appropriate regulatory authorities, including the FDA. While we investigated each of the
incidents and believe we have taken the necessary corrective actions, we cannot guarantee that
malfunctions will not occur in the future. If they do occur, we may elect to take voluntary
corrective action, and we may be subject to involuntary corrective action such as notification,
fines, seizures or recalls. If someone is harmed by a malfunction or by product mishandling, we may
be subject to product liability claims. Any corrective action, whether voluntary or involuntary, as
well as defending ourselves in a lawsuit, will require the dedication of our time and capital,
distract management from operating our business, and may harm our reputation and financial results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Use of Proceeds

On June 15, 2006, we completed an initial public offering of 7,820,000 shares of our common stock,
which included 1,020,000 shares sold pursuant to the exercise of the underwriters over-allotment
option. Proceeds from our initial public offering, after deducting offering expenses and
underwriting discounts and commissions, were $54.5 million. Pursuant to a subordinated debt
agreement entered into in December 2003, we repaid the outstanding balance of $29.2 million on our
senior subordinated notes, as required by their terms, with a portion of the proceeds from our
initial public offering. In addition, through June 30, 2007, $3.1 million was used for other debt
repayment, $6.5 million was used for capital expenditures and $422,000 was used for the acquisition
of intangibles. The remaining net proceeds have been invested in short-term investments in
accordance with our investment policy.

We expect to use the remaining net proceeds from our initial public offering for sales and
marketing initiatives to support the ongoing commercialization of our products and to use the
remainder of our net proceeds for research and development activities and general corporate
purposes.

Our Annual Meeting of Stockholders was held on June 7, 2007. Of the 38,341,636 shares of common
stock entitled to vote at the meeting, 33,597,119 shares, representing 87.6% of the votes eligible
to be cast, were represented at the meeting in person or by proxy, constituting a quorum. Proxies
for the meeting were solicited by our Board of Directors pursuant to Section 14(a) of the
Securities Exchange Act of 1934, as amended, and there was no solicitation in opposition to the
Boards solicitations. The final votes on the proposals presented at the meeting were recorded as
follows:

(a)

The stockholders elected Carlos A. Ferrer and James C. Blair, Ph.D. for a three-year
term to expire at the 2010 Annual Meeting of Stockholders by the following vote:

Votes in

Votes

Name

Favor

Withheld

Carlos A. Ferrer

25,392,507

8,204,612

James C. Blair, Ph.D.

31,330,883

2,266,236

The terms of the other members of our Board of Directors, Olav B. Bergheim, Connie R. Curran, RN,
Ed.D., Lesley H. Howe, R. Scott Huennekens and Ronald A. Matricaria, continued after the Annual
Meeting of Stockholders. Effective July 12, 2007, Carlos A. Ferrer resigned from our Board of
Directors and effective as of June 7, 2007 and July 17, 2007, respectively, our Board of Directors
elected John Onopchenko and Kieran T. Gallahue to serve on the Board of Directors.

(b)

The stockholders approved an amendment to our 2005 Equity Compensation
Plan (the 2005 Plan) to (a) increase by 3,500,000 the maximum number
of shares of common stock that may be issued under the 2005 Plan and
(b) to place certain limitations on the grant of stock options and
performance-based stock awards under the 2005 Plan by a vote of
23,161,881 in favor, 7,337,258 votes against and 30,202 votes
withheld.

(c)

The stockholders approved the adoption of our 2007 Employee Stock
Purchase Plan (the Purchase Plan) by a vote of 26,082,293 in
favor, 4,434,718 votes against and 12,331 votes withheld.

(d)

The stockholders ratified the selection of Ernst & Young LLP as
our independent registered public accounting firm for the fiscal
year ending December 31, 2007 by a vote of 33,567,029 in favor,
15,654 votes against and 14,435 votes withheld.

Asset Purchase Agreement, by and among Jomed Inc., Jomed N.V., Jomed GmBH,
Jomed Benelux S.A. and the Registrant, dated July 10, 2003 (filed as
Exhibit 2.1 to the Registrants Registration Statement on Form S-1, as
amended (File No. 333-132678), as originally filed on March 24, 2006, and
incorporated herein by reference).

2.2

Asset Transfer Agreement, by and between Pacific Rim Medical Ventures
Corp. and Koninklijke Philips Electronics N.V., dated July 3, 2003 (filed
as Exhibit 2.2 to the Registrants Registration Statement on Form S-1, as
amended (File No. 333-132678), as originally filed on March 24, 2006, and
incorporated herein by reference).

3.1

Amended and Restated Certificate of Incorporation of the Registrant (filed
as Exhibit 3.1 to the Registrants Quarterly Report on Form 10-Q (File No.
000-52045), as originally filed on August 9, 2006, and incorporated herein
by reference).

3.2

Bylaws of the Registrant (filed as Exhibit 3.3 to the Registrants
Quarterly Report on Form 10-Q (File No. 000-52045), as originally filed on
August 9, 2006, and incorporated herein by reference).

3.3

Certificate of Designation of Series A Junior Participating
Preferred Stock (filed as Exhibit 3.2 to the Registrants Quarterly Report
on Form 10-Q (File No. 000-52045), as originally filed on August 9, 2006,
and incorporated herein by reference).

4.1

Reference is made to Exhibits 3.1, 3.2 and 3.3.

4.2

Specimen Common Stock certificate of the Registrant (filed as Exhibit 4.1
to the Registrants Registration Statement on Form S-1/A, as amended (File
No. 333-132678), as originally filed on May 24, 2006, and incorporated
herein by reference).

4.3

Amended and Restated Investors Rights Agreement, by and among the
Registrant and certain stockholders, dated February 18, 2005 (filed as
Exhibit 4.2 to the Registrants Registration Statement on Form S-1, as
amended (File No. 333-132678), as originally filed on March 24, 2006, and
incorporated herein by reference).

4.4

Warrant to purchase shares of Series B Preferred Stock, issued by the
Registrant to Venture Lending & Leasing IV, LLC, dated September 30, 2004
(filed as Exhibit 4.4 to the Registrants Registration Statement on Form
S-1, as amended (File No. 333-132678), as originally filed on March 24,
2006, and incorporated herein by reference).

4.5

Warrant to purchase shares of common stock, issued by the Registrant to
Silicon Valley Bank, dated July 18, 2003 (filed as Exhibit 4.8 to the
Registrants Registration Statement on Form S-1, as amended (File No.
333-132678), as originally filed on March 24, 2006, and incorporated
herein by reference).

4.6

Warrant to purchase shares of Series B Preferred Stock, issued by the
Registrant to Silicon Valley Bank, dated July 18, 2004 (filed as Exhibit
4.9 to the Registrants Registration Statement on Form S-1, as amended
(File No. 333-132678), as originally filed on March 24, 2006, and
incorporated herein by reference).

4.7

Rights Agreement, by and between the Registrant and American Stock
Transfer & Trust Company, dated June 20, 2006 (filed as Exhibit 4.1 to the
Registrants Quarterly Report on Form 10-Q (File No. 000-52045), as
originally filed on August 9, 2006, and incorporated herein by reference).

10.19

Director Compensation Policy, as amended by the Registrant on June 6, 2007.

31.1

Certification of the President & Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.

31.2

Certification of the Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.

32.1*

Certification of the President & Chief Executive Officer pursuant to Rule
13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

32.2*

Certification of the Chief Financial Officer pursuant to Rule 13a-14(b) of
the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.

*

The certifications attached as Exhibit 32.1 and Exhibit 32.2 accompany
this quarterly report on Form 10-Q pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
and shall not be deemed filed by Volcano Corporation for purposes of
Section 18 of the Securities Exchange Act of 1934, as amended.

Asset Purchase Agreement, by and among Jomed Inc., Jomed N.V., Jomed GmBH,
Jomed Benelux S.A. and the Registrant, dated July 10, 2003 (filed as
Exhibit 2.1 to the Registrants Registration Statement on Form S-1, as
amended (File No. 333-132678), as originally filed on March 24, 2006, and
incorporated herein by reference).

2.2

Asset Transfer Agreement, by and between Pacific Rim Medical Ventures
Corp. and Koninklijke Philips Electronics N.V., dated July 3, 2003 (filed
as Exhibit 2.2 to the Registrants Registration Statement on Form S-1, as
amended (File No. 333-132678), as originally filed on March 24, 2006, and
incorporated herein by reference).

3.1

Amended and Restated Certificate of Incorporation of the Registrant (filed
as Exhibit 3.1 to the Registrants Quarterly Report on Form 10-Q (File No.
000-52045), as originally filed on August 9, 2006, and incorporated herein
by reference).

3.2

Bylaws of the Registrant (filed as Exhibit 3.3 to the Registrants
Quarterly Report on Form 10-Q (File No. 000-52045), as originally filed on
August 9, 2006, and incorporated herein by reference).

3.3

Certificate of Designation of Series A Junior Participating
Preferred Stock (filed as Exhibit 3.2 to the Registrants Quarterly Report
on Form 10-Q (File No. 000-52045), as originally filed on August 9, 2006,
and incorporated herein by reference).

4.1

Reference is made to Exhibits 3.1, 3.2 and 3.3.

4.2

Specimen Common Stock certificate of the Registrant (filed as Exhibit 4.1
to the Registrants Registration Statement on Form S-1/A, as amended (File
No. 333-132678), as originally filed on May 24, 2006, and incorporated
herein by reference).

4.3

Amended and Restated Investors Rights Agreement, by and among the
Registrant and certain stockholders, dated February 18, 2005 (filed as
Exhibit 4.2 to the Registrants Registration Statement on Form S-1, as
amended (File No. 333-132678), as originally filed on March 24, 2006, and
incorporated herein by reference).

4.4

Warrant to purchase shares of Series B Preferred Stock, issued by the
Registrant to Venture Lending & Leasing IV, LLC, dated September 30, 2004
(filed as Exhibit 4.4 to the Registrants Registration Statement on Form
S-1, as amended (File No. 333-132678), as originally filed on March 24,
2006, and incorporated herein by reference).

4.5

Warrant to purchase shares of common stock, issued by the Registrant to
Silicon Valley Bank, dated July 18, 2003 (filed as Exhibit 4.8 to the
Registrants Registration Statement on Form S-1, as amended (File No.
333-132678), as originally filed on March 24, 2006, and incorporated
herein by reference).

4.6

Warrant to purchase shares of Series B Preferred Stock, issued by the
Registrant to Silicon Valley Bank, dated July 18, 2004 (filed as Exhibit
4.9 to the Registrants Registration Statement on Form S-1, as amended
(File No. 333-132678), as originally filed on March 24, 2006, and
incorporated herein by reference).

4.7

Rights Agreement, by and between the Registrant and American Stock
Transfer & Trust Company, dated June 20, 2006 (filed as Exhibit 4.1 to the
Registrants Quarterly Report on Form 10-Q (File No. 000-52045), as
originally filed on August 9, 2006, and incorporated herein by reference).

10.19

Director Compensation Policy, as amended by the Registrant on June 6, 2007.

31.1

Certification of the President & Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.

31.2

Certification of the Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended.

32.1*

Certification of the President & Chief Executive Officer pursuant to Rule
13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

32.2*

Certification of the Chief Financial Officer pursuant to Rule 13a-14(b) of
the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.

*

The certifications attached as Exhibit 32.1 and Exhibit 32.2 accompany
this quarterly report on Form 10-Q pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
and shall not be deemed filed by Volcano Corporation for purposes of
Section 18 of the Securities Exchange Act of 1934, as amended.